Purpose of Securitisation
A lender or a financier provides loans to borrowers and gets repayment with interest over a period. Usually, the lender collects the periodic instalments and uses them to finance new loans. Thus, his capacity to give new loans is limited as he has to wait until he recovers the instalments and interest. But, through the securitisation of debt, he can pool the loans together and sell his rights to receive consideration immediately by securitising his loan portfolio at a discounted value. Now, he can again start his financing business.
Securitisation with or without Recourse
The term recourse refers to avenues of securing debt instruments that offer recoup to lenders if the borrower defaults and the value of the underlying asset or collateral is not enough to recover the loaned amount. In such cases, lenders can pursue other recourse to recover the debt.
Securitisation with recourse generally involves securitised debts. In such cases, the investor and/or the asset reconstruction company or the particular purpose vehicle can receive both the principal and interest from the financing company or the original lender, even if the borrower fails to pay.
For securitisation without recourse, the entire credit risk falls upon the investors and/or the asset reconstruction or management company, as they do not get to return from finance companies in cases of default.
Definition of ‘Securitisation’
Securitisation is the process of pooling together products of similar financial asset classes and then packaging them as marketable financial instruments. Similar types of loans are clubbed together and then put up for sale in the secondary market as debt securities.
Here’s a much more formal definition as per a master circular by the Reserve Bank of India:
Securitisation is transactions wherein financial asset credit risk is controlled by redistributing risks using tradable or marketable securities. Different debt-based financial assets are packaged and sold as debt securities to investors who share the credit risks and offer liquidity to lenders through their investments.
Assets that can be Securitised
In truth, any financial assets that generate steady cash flows can be securitised. All types of loans are assets for banks as they offer periodic payments to the lender. Asset backed loans, mortgage backed loans, home loans, auto loans, consumer loans, credit card & trade receivables, etc.– any credit asset with a healthy financial performance can be a good choice for securitisation.
Long Dated Assets and Short Dated Funding Sources
Long-term assets such as mortgage loans and 40-year bonds generate a steady stream of revenue until the maturity date. However, they feature higher risks as well.
On the other hand, short-dated funding sources include line of credits, bill discounting, invoice discounting, term loans, commercial bank loans, etc. Most assets and liabilities of a bank are of short-term nature.
Mortgage Securitisation or Asset Securitisation
Securitisation can be mortgage-backed, asset-backed or recourse based. While the basic idea underlying asset and mortgage-backed securities are quite similar, there are certain key differences.
The mortgage securitisation process pools multiple mortgage-backed loans and converts them into tradable mortgage-backed securities. Most MBS are based on mortgage loans or housing loans.
Asset securitisation converts pools of asset-backed loans (non-mortgage assets), such as credit card debts, education loans, lines of credit, etc. into marketable securities to investors. The underlying investments are the security against the credit risk involved.
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Benefits of Securitisation
Securitisation offers several benefits to the seller, investor, and debt markets such as:
For the seller or originator, securitisation mainly improves liquidity. It removes the assets from the originator’s balance sheet, thus liberating capital for other uses and enabling the restructuring of the balance sheet.
For the investor, securitisation provides an avenue for a relatively risk-free investment. It allows investors to acquire good-quality assets and diversify their portfolios.
For the debt market, securitisation increases the number of securitised debt instruments and provides additional liquidity. Securitisation also widens the market by facilitating unbundling, better allocation, and managing project risks by attracting new players.
Benefits of Securitisation in a nutshell are:
- Helps banks reduce the need for additional capital by keeping loans off their balance sheet.
- Securitisation is an alternative form to banks/financial institutions of funding risk transfer and capital market development.
- It helps improve liquidity by reducing lending concentration.
- Funds can be attained at lower costs due to their isolation from the potential bankruptcy risk of the originator.
- Provides better match of assets and liabilities and development of long-term debt market
- Helps in providing a diversified pool of uniform assets to banks and financial institutions
- Helps in converting non-liquid loans or assets into liquid assets or marketable securities.
- Securitisation helps transfer funds from a less efficient debt market to a more efficient capital market.
How Securitisation Works?
The process of securitisation works in the following manner:
- The lender sells several types of loans to borrowers.
- The lender packs certain loans together and sells these to the Asset Reconstruction Company (ARC).
- The Asset Reconstruction Company, in turn, makes payment to the original lender for the loans purchased.
- These loans are then converted into a pool of securities by the Asset Reconstruction Company for issuing Pass-Through Certificates or Pay Through Certificates (PTC).
- In Pass-through certificates, the cash is collected by the original lender, and then passed on to the Special Purpose Vehicle (SPV).
- For Pay through certificates, usually, the cash is collected by the Special Purpose Vehicle (SPV) from the borrower and then distributed to the certificate holders. These Pay Through Certificates-PTCs are further sold to individual investors.
- In the case of Pass-Through Certificates, the recoveries from the original borrower are obtained by the original lender, and in the case of Pay-Through Certificates by Asset Reconstruction Company.
- If the original borrower makes the collection, he is under obligation to pass on the money to Asset Reconstruction Company (ARC), which in turn passes on these amounts to the investors.
Why is Securitisation for you?
Securitisation is an essential function of the modern financial system, and a securitisation platform makes it simpler for you to carry out the transactions. Yubi Pool– the securitisation platform of Yubi is a one-stop solution for all your securitisation needs. Yubi Pool is transforming the Asset-Backed Securitisation (ABS) market and bringing unparalleled efficiencies and a data-driven approach to ABS deal-making. Yubi Pool‘s comprehensive product capabilities serve varying needs throughout the Securitisation & Direct Assignment (DA) lifecycle.
Securitising helps to reduce debt from the balance sheet and helps to provide additional liquidity, which can be used to make new loans. Yubi Pool provides an easily executed Price discovery vs Loan product model with compliance modules for pre-and post-settlement requirements. You can also discover better pricing with a simpler process to enhance your experience.
ABS or Asset-Backed Securities present an opportunity to invest in asset securitisation classes otherwise not accessible in the markets that offer an attractive risk/return profile. Yubi Pool provides a comprehensive asset quality check and sanctity check of data leading to a reduced load on the investors.
Techniques of Credit Enhancement
Credit Enhancement denotes techniques and practices adopted by companies to enhance their creditworthiness. Such practices help companies secure better repayment terms for their debt as well as reduce the risk of investors in an associated specially structured product. Credit enhancement reduces the risk of default associated with underlying asset pool.
Some of the most prominent methods used for credit enhancement are as follows:
- Excess Spread: The rate of return of the securities is made lower than the interest rate of the underlying asset.
- Overcollateralisation: The total value of the underlying securitised assets are greater than the nominal value of the associated securities issued.
- Subordination: The securities up for trade are sub-divided hierarchically into series of tranches. Tranches are related to each other in the sense that the repayment of a particular tranche depends upon, that is, is subordinate to the successful repayment of the tranche immediately above it in hierarchy. Higher the credit risk of a tranche, higher the interest of a tranche. High tranches enjoy higher priorities than the intermediate ones.
- Margin Deposit: The assignor of a security makes a certain margin deposit to the asset reconstruction company or the special purpose vehicle.
- Guarantee by a Third Party: A third party such as a specialised insurance company can provide guarantee cover for certain types of securities.
- Derivatives (credit derivatives): Credit derivatives are designed to transfer & reduce the credit risk involved in a pool of securitised assets. A third party often bears the risk in these cases in exchange for a certain premium.
Public Issue and Listing of Securitised Certificates or Instruments
The Securities Contracts (Regulation) Act, especially Section 17a, defines all the rules & provisions for public issuing and listing of the securitised assets or instruments. The Securities & Exchanges Board of India’s (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 also dictates the different provisions regarding publicly offering and listing of securitised loan assets or debt instruments.
Securitised Certificate or Instrument – A securitised debt instrument or certificate can be defined as any tradable financial instrument that’s issued to an investor by any issuer, which is a special purpose vehicle or entity that possesses a pool of debts or receivables such as mortgage or asset-backed debt assigned to such an entity and offers an associated interest return to the investor investing in the debt or receivable, including any mortgage debt or other debt instruments as defined under the [Section 2(h)(ie) of Securities Contracts (Regulation) Act].
Listing and Issue of Securities – Asset reconstruction or special purpose vehicles must market only those type of securities that meet the eligibility criteria defined by the laws & statutes specified by SEBI as well as follow all the requirements laid don by the governing body. The criteria and requirements are defined in [section 17A(1) of SCRA].3
The issuer of a particular securitised or instrument will have to send an application for listing their marketable securitised product on one or more recognised stock exchanges. This is to be done before they issue any related documents to the public, as per [section 17A(2) of SCRA].
In case any stock exchange refuses to list a security, the issuer is to repay all the money to all applicants within eight working days. If repayments are not done within that period, issuers are liable to pay an interest to all applicants at 15% as per [section 17A(3)]. All legal and regulatory provisions related to secondary market listing of debt securities shall apply to the listing processes of all such securities as per [section 17A(4) of SCRA].
Real-World Examples of Securitization
- Government National Mortgage Association (GNMA)
- Federal National Mortgage Association (FNMA)
- Federal Home Loan Mortgage Corporation (FHLMC)
Basically, all assets which generate cash flow can be securitised, e.g., mortgage loans, housing loans, automobile loans, credit card receivables, trade receivables, consumer loans, lease finance, etc. A perfectly healthy and normal financial asset usually is securitised.
Asset Reconstruction Company (ARC) means a company registered with RBI to carry on the business of securitisation and reconstruction of financial assets or both.
The advantages of securitisation are:
- Improves liquidity by turning illiquid assets into liquid ones
- Frees up capital for the originator
- Provides income for investors
- Allows small investors to play
Mortgage-backed security (MBS) is an excellent example of securitisation. Combining mortgages into one extensive portfolio, the issuer can divide the pool into small pieces and then sell to investors, each packaged as a type of bond.
Securitisation is used to redistribute the credit risks associated with debt assets from lending institutions to investors. Through securitisation, lending institutions reduce risks in their balance sheets, turn illiquid assets into liquid ones, and free up their capital.
Securitisation for MSME involves securitising MSME loans, which will unlock capital markets and channel much-needed liquidity to the investment-starved MSME sector.
Securitisation of loans offered by public sector banks can be an excellent way to boost up liquidity and reduce capital requirements.
Securitisation of micro-financing institutions can help MFIs offer cheaper credit and disburse loans at faster rates, all the while remaining financially sustainable.
Banks securitise loans to reduce credit risks. improve their balance sheets, free up capital, and gain liquidity for further disbursal of loans.
Securitisation allows lender or originators to offer diverse funding schemes, injects liquidity into the finance sector, help creditors/originators manage risks better, and helps make the financial market more efficient.
While they do not provide any financing products, asset reconstruction companies are listed as non banking financial institutions. They are special purpose vehicles that pool personal loans, residential mortgages, asset backed loans, etc. and repackages them as tradable debt securities to be sold on the secondary market.